The problem with the business cycle under this analysis, you’ll notice, is not the bust ”” it’s the boom. That’s when the bad investment decisions are made, largely because political influence in the markets (housing policy, tax breaks, artificially cheap money and other interest-rate subsidies, risk subsidies, etc.) distorts economic calculation.

Which brings us back to the entitlements. It’s easy to say: Well, we’ll just raise the retirement age, or cut benefits, or means-test them, or raise taxes on the wealthy who receive them (which amounts to means-testing, but Democrats like that version better). And, yes, that probably is what we will do, eventually. But that does not get us out of the economic pickle: People have been making decisions for years and years ”” decisions about saving, investing, consuming, working, and retiring ”” based at least in some part on what are almost certainly faulty assumptions about what sort of Social Security, Medicare, and other benefits they will receive when they retire. When those disappear, a lot of consumption is going to have to be forgone ”” and a lot of capital dedicated to producing those goods and services for consumption will be massively devalued. Businesses will have to retrench, probably in a way that is more disruptive and more expensive than the housing-bubble recession necessitated.

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Efforts to tame America’s ballooning budget deficit could soon confront a daunting reality: Nearly half of all Americans live in a household in which someone receives government benefits, more than at any time in history.

At the same time, the fraction of American households not paying federal income taxes has also grown””to an estimated 45% in 2010, from 39% five years ago, according to the Tax Policy Center, a nonpartisan research organization.

A little more than half don’t earn enough to be taxed; the rest take so many credits and deductions they don’t owe anything. Most still get hit with Medicare and Social Security payroll taxes, but 13% of all U.S. households pay neither federal income nor payroll taxes.

“We have a very large share of the American population that is getting checks from the government,” says Keith Hennessey, an economic adviser to President George W. Bush and now a fellow at the conservative Hoover Institution, “and an increasingly smaller portion of the population that’s paying for it.”

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Households and corporations alike are refinancing their loans in droves to take advantage of interest rates that seem impossibly cheap. But those same low rates come with a flip side, driving down the income of retirees and others who live off their savings.

It is a side effect of a government policy meant to push down interest rates to a point that businesses and consumers are compelled to borrow and spend again, and yet it is hurting anyone with a savings account.

With the regulated rate that financial institutions can borrow from one another at almost zero, banks are paying savers next to nothing. The average returns on interest-bearing deposit accounts slipped to 0.99 percent in July, according to Market Rates Insight, which tracks bank rates. It is the first time its measure has dipped below 1 percent since the 1950s, when its data begins.

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Pundits are restless, an election looms ”“ so this week, President Barack Obama is proposing yet another round of special favors, aimed at improving the economy. Prominent columnist Paul Krugman wants the plans to be “bold” and to involve huge amounts of money. Here’s a contrasting view: government should stop declaring recovery plans, bold or otherwise.

Maybe the constant announcing of new plans ”“ especially plans backed by borrowing or tax cuts ”“ is, itself, an impediment to economic growth.

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The unexpectedly deep plunge in home sales this summer is likely to force the Obama administration to choose between future homeowners and current ones, a predicament officials had been eager to avoid.

Over the last 18 months, the administration has rolled out just about every program it could think of to prop up the ailing housing market, using tax credits, mortgage modification programs, low interest rates, government-backed loans and other assistance intended to keep values up and delinquent borrowers out of foreclosure. The goal was to stabilize the market until a resurgent economy created new households that demanded places to live.

As the economy again sputters and potential buyers flee ”” July housing sales sank 26 percent from July 2009 ”” there is a growing sense of exhaustion with government intervention. Some economists and analysts are now urging a dose of shock therapy that would greatly shift the benefits to future homeowners: Let the housing market crash.

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The U.S. economy will eventually rebound from the Great Recession. Millions of American workers will not.

What some economists now project ”” and policymakers are loath to admit ”” is that the U.S. unemployment rate, which stood at 9.6% in August, could remain elevated for years to come.

The nation’s job deficit is so deep that even a powerful recovery would leave large numbers of Americans out of work for years, experts say. And with growth now weakening, analysts are doubtful that companies will boost payrolls significantly any time soon. Unemployment, long considered a temporary, transitional condition in the United States, appears to be settling in for a lengthy run.

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The Obama administration and the Federal Reserve want to fix the United States economy by spending more money. But while that approach might work for Europe, it is risky for the US. The nation would be better off embracing traditional American values like self-reliance and small government.

There’s no question about it: The 20th century was America’s era. The United States rose rapidly from virtually nothing to become the most politically powerful and economically strongest country in the world. But the financial crisis and subsequent recession have now raised doubts about its future. Are we currently witnessing the beginning of the end of the American era?

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Slow growth will have Washington seeking stimulus. This may be a better-than-expected jobs report, but the job growth is still very small. The economy needs to be adding hundreds of thousands of jobs every month to absorb new people entering the job market and put the unemployed back to work. So lawmakers may be looking for more stimulus. “There is a good chance that the Obama Administration will introduce a set of targeted economic stimulus programs,” [Sung Won] Sohn says. “Payroll tax relief to encourage new hiring for small businesses is a good possibility. State and local governments are laying off employees as revenue falls. Some assistance from Washington could stem job losses here.” Shortly after the release of the August jobs report Friday, President Obama encouraged lawmakers to pass a $55 billion bill that would provide additional loans to small businesses. Housing stimulus may also be coming–along with more unemployment benefit extensions, Sohn says.

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This coming Monday marks the second Labor Day of the Obama administration, and the American work force has little to show for it other than higher unemployment, stagnant wages, last year’s $1.4 trillion federal deficit, this year’s $1.3 trillion deficit, and next year’s anticipated $1 trillion-plus deficit. Oh, and a slew of new federal regulations and programs””like ObamaCare””that will make it even more expensive for businesses to retain current workers, much less create new jobs.

No wonder American confidence in the future is evaporating. And when confidence crumbles, consumers won’t spend, lenders won’t lend, investors won’t invest, and businesses won’t hire.

Today we see businesses husbanding cash rather than hiring. Nonfinancial S&P 500 companies are sitting on a record $837 billion. Personal savings are increasing dramatically, to over 6% of income today compared to barely 1% in 2005. Those small businesses still willing to take on more debt to expand are having tremendous difficulty finding credit.

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2) Payroll tax cut is not a bad idea for stimulus, but U.S. has longer-term job and growth problem that needs to be addressed.

3) Payroll tax cut for $400 billion in early 2009 would have been better than Obama’s $862 billion plan.

4) Any short-term tax cut should be coupled with long-term deficit reduction plan.

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…the most effective tax cut for putting people back to work quickly is one that businesses and households get only if they spend money. Last year’s cash-for-clunkers program was an example. So was a recent bipartisan tax credit for businesses that hired workers who had been unemployed for months. Perhaps the broadest example is a temporary cut in the payroll tax for businesses, which reduces the cost of employing people.

Any of these steps would increase the budget deficit, obviously. But relative to the multitrillion-dollar, Medicare-driven, long-term deficit, a temporary tax cut costing a couple of hundred billion dollars isn’t significant. The more pressing problem today, by far, is the weak economy.

The great historical lesson of financial crises is that governments are usually not aggressive enough in responding. That was Japan’s mistake in 1990s, Herbert Hoover’s in the early 1930s and even Franklin Roosevelt’s in the mid-1930s.

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The American economy could experience painfully slow growth and stubbornly high unemployment for a decade or longer as a result of the 2007 collapse of the housing market and the economic turmoil that followed, according to an authority on the history of financial crises.

That finding, contained in a new paper by Carmen M. Reinhart, an economist at the University of Maryland, generated considerable debate during an annual policy symposium here, organized by the Federal Reserve Bank of Kansas City, which concluded on Saturday.

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It increasingly seems as if the policy makers attending like physicians to the American economy are peering into their medical kits and coming up empty, their arsenal of pharmaceuticals largely exhausted and the few that remain deemed too experimental or laden with risky side effects. The patient ”” who started in critical care ”” was showing signs of improvement in the convalescent ward earlier this year, but has since deteriorated. The doctors cannot agree on a diagnosis, let alone administer an antidote with confidence.

This is where the Great Recession has taken the world’s largest economy, to a Great Ambiguity over what lies ahead, and what can be done now. Economists debate the benefits of previous policy prescriptions, but in the political realm a rare consensus has emerged: The future is now so colored in red ink that running up the debt seems politically risky in the months before the Congressional elections, even in the name of creating jobs and generating economic growth. The result is that Democrats and Republicans have foresworn virtually any course that involves spending serious money.

The growing impression of a weakening economy combined with a dearth of policy options has reinvigorated concerns that the United States risks sinking into the sort of economic stagnation that captured Japan during its so-called Lost Decade in the 1990s.

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The crucial issue [on the economy] is getting the fundamentals right. The Germans are doing better because during the past decade, they took care of their fundamentals and the Americans didn’t.

The situation can be expressed this way: German policy makers inherited a certain consensus-based economic model. That model has advantages. It fosters gradual innovation (of the sort useful in metallurgy). It also has disadvantages. It sometimes leads to rigidity and high unemployment.

Over the past few years, the Germans have built on their advantages. They effectively support basic research and worker training. They have also taken brave measures to minimize their disadvantages. As an editorial from the superb online think tank e21 reminds us, the Germans have recently reduced labor market regulation, increased wage flexibility and taken strong measures to balance budgets.

In the U.S., policy makers inherited a different economic model, one that also has certain advantages. It fosters disruptive innovation (of the sort useful in Silicon Valley). It also has certain disadvantages ”” a penchant for over-consumption and short term thinking.

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“The economy is going to limp along for the next few months,” said Gus Faucher, an economist at Moody’s Analytics. There’s even a one in three chance it could slip back into recession, he said.

Many temporary factors that boosted the economy earlier this year are fading. Companies built up their inventories after cutting them sharply in the recession to match slower sales. The increase provided a boost to manufacturers, but now many companies’ stockpiles are in line with sales and don’t need to grow as much. In addition, the impact of the government’s $862 billion fiscal stimulus program is lessening. That leaves the private sector to pick up the slack. But businesses are cutting back on their spending on machines, computers and software, according to a government report earlier this week. And the housing sector is slumping again after a popular home buyer’s tax credit expired in April.

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[Paul] Otellini singled out the political state of affairs in Democrat-dominated Washington, saying: “I think this group does not understand what it takes to create jobs. And I think they’re flummoxed by their experiment in Keynesian economics not working.”

Since an unusually sharp downturn accelerated in late 2008, the Obama administration and its allies in the U.S. Congress have enacted trillions in deficit spending they say will create an economic stimulus — but have not extended the Bush tax cuts and have pushed to levy extensive new health care and carbon regulations on businesses.

“They’re in a ‘Do’ loop right now trying to figure out what the answer is,” Otellini said.

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Fannie and Freddie function by buying, bundling and then stamping a government guarantee on mortgages. Then they sell them to investors. It keeps the banks happy because it keeps capital flowing, and it keeps consumers happy because it makes low, fixed-rate mortgages possible.

At least that how things were supposed to unfold. But the two mortgage finance giants “made astonishing mistakes,” Raj Date, executive director of a financial policy think-tank called the Cambridge Winter Center, told NPR’s Audie Cornish.

“As normal people everywhere in the country realized that housing prices seemed to be growing straight into the stratosphere, instead of becoming more conservative about lending against those ridiculously high values, Fannie and Freddie just continued to make the same kind of loans and indeed made more aggressive loans during that period of 2005, 2006, 2007,” Date said. “And it has all come back to haunt them.”

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Every day, an average of 112 people — most of them the newly poor — sign up for free government health care in South Carolina.

Since the recession officially hit in December 2007, some 3,300 people a month, on average, have signed up for Medicaid in a state that outpaces the nation for poverty, obesity and diseases such as diabetes. Yet, South Carolina’s political leaders have been among the most vocal in the country in opposition of the new health care law….

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The consequences of doing nothing would be painful. But they would be far less harmful than the consequences of an unconditioned federal bailout, which would mean massive new fiscal commitments at the federal level.

Unfortunately, leaders in Illinois and elsewhere are now talking quietly about the possibility of a federal bailout. Such speculation undermines state and local efforts to reform pension systems or make other hard choices. Why agonize over unpopular budget cuts or tax increases if the feds will ride to the rescue?

Bailing out state pensions would be astronomically expensive. According to a Pew Foundation estimate this year, the total unfunded liabilities of the 50 states’ pension funds amounted to about $1 trillion in 2008. Another recent study, by Josh Rauh of Northwestern and Robert Novy-Marx of the Chicago Booth School of Business, estimated that the unfunded liability was closer to $3 trillion. Adding the liabilities of municipal pension funds makes the total even larger.

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From here:

While Druckenmiller doesn’t expect the U.S. to slip back into recession, he sees growth remaining weak as banks lend less and companies hold back on hiring and capital expenditures.

He’s concerned that with interest rates near zero, neither the government nor consumers will pay down their debts.

“We are setting ourselves up for a much worse problem if we don’t deleverage,” he said.

We don’t have alternative universe laboratories to run control bailout experiments, but we can imagine the alternative outcomes if different actions were taken.

So let’s do just that. Imagine a nation in the midst of an economic crisis, circa September-December 2008. Only this time, there are key differences: 1) A President who understood Capitalism requires insolvent firms to suffer failure (as opposed to a lame duck running out the clock); 2) A Treasury Secretary who was not a former Goldman Sachs CEO, with a misguided sympathy for Wall Street firms at risk of failure (as opposed to overseeing the greatest wealth transfer in human history); 3) A Federal Reserve Chairman who understood the limits of the Federal Reserve (versus a massive expansion of its power and balance sheet).

In my counter factual, the bailouts did not occur. Instead of the Japanese model, the US government went the Swedish route of banking crises: They stepped in with temporary nationalizations, prepackaged bankruptcies, and financial reorganizations; banks write down all of their bad debt, they sell off the paper. Int he end, the goal is to spin out clean, well financed, toxic-asset-free banks into the public markets.

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Seldom does the United States look at Europe with economic envy. The past few weeks, however, have been one of those rare phases. Concern about America’s stumbling recovery has been rising, just as anxieties about the euro area’s economy have faded. The dollar is the weakling among rich-world currencies…. But Americans should take a little heart: it is too soon to despair about their economy. And Europeans should show a little caution: it is too soon to be sure that theirs is firmly back on its feet.

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As if there weren’t enough hot-button issues for debate in the 2010 midterm elections, Social Security is emerging as another one.

Democrats have been taking the offensive, apparently hoping to use the issue to their advantage as they fight to maintain control of Congress. They’re emphasizing the program’s popularity among Americans, their commitment to protecting it, and their contention that Republicans want to change Social Security to its detriment.

Social Security’s 75th anniversary is Saturday, and Democrats have tied some of their efforts to that milestone. President Obama, for one, talked about Social Security during his weekly address on Saturday.

“We have an obligation … to safeguard Social Security for our seniors, people with disabilities, and all Americans ”“ today, tomorrow, and forever,” he said. “But what we can’t afford to do is privatize Social Security.”

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One problem that dogged Japan during its lost decade was a stop-and-go fiscal policy in which stimulus packages were administered in an “on again, off again” fashion and taxes were lowered and then raised. There is a risk that the U.S. could fall into this trap in an effort to strike a balance between short-term fiscal support and long-term budget integrity.

This strongly suggests that congressional leaders of both parties should embrace a pro-growth fiscal reform that would help to create long-run fiscal stability and foster certainty about future tax rates. With the 2001-2003 tax cuts set to expire at the end of 2010, the time is now to move ahead with broad-based reform.

A good starting point would be the bipartisan Wyden-Gregg tax reform bill. This bill is not incredibly bold, but is probably the best we could do in the current environment and is much better than the current tax code.

Wyden-Gregg would be revenue-neutral; it would simplify the tax code by reducing the number of personal income tax brackets to three from six and would do so without raising marginal income tax rates.

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From the FT’s Alphaville blog:

So the US Treasury’s centrepiece mortgage modification programme ”” Hamp ”” is something of a failure. That much we knew already.

But Laurie Goodman over at Amherst Securities brings up another point.

The programme actually has a lower success rate than other modification programmes ”” even those that involve a similar amount of payment reduction.

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Underpinning the gloom: Nearly two-thirds of Americans believe the economy has yet to hit bottom, a sharply higher percentage than the 53% who felt that way in January.

The sour national mood appears all-encompassing and is dragging down ratings for the GOP too, suggesting voters above all are disenchanted with the political establishment in Washington. Just 24% express positive feelings about the Republican Party, a new low in the 21-year history of the Journal’s survey. Democrats are only slightly more popular, but also near an all-time low.

The results likely foreshadow a poor showing in November’s mid-term for Democrats, whose leaders had hoped the public would grow more optimistic about the economy and, as a result, more supportive of the party agenda. Now, despite the weak Republican numbers, the survey shows frustrated voters on the left are less interested than impassioned voters on the right to in the election.

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… applying the brakes to runaway federal spending will not be easy. As the first reaction to [Defense Secretary Robert] Gates’s announcement showed, whatever their proclaimed ideology, local politicians will squeal when their constituents feel the budget ax.

Among the first to challenge Gates’s decision to eliminate the Virginia-based military command was Virginia Gov. Robert McDonnell, a Republican who has not hesitated to trim spending proposals by his Democratic predecessors.

He was joined by the state’s two Democratic senators, Mark Warner and Jim Webb, who talk a good game of budgetary responsibility but squirm when it hits home.

Obama may have thought it was tough work to push Congress into spending all that he wanted for economic stimulus, education and other causes close to his heart. He is about to learn that nudging the lawmakers to trim the budget may be even tougher.

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In 1995, the federal government, led by the Liberal Party, passed the most important budget in three generations. Federal spending was reduced almost 10% over two years and federal employment was slashed 14%. By 1998, the federal government was in surplus and reducing the nearly $650 billion national debt. Provincial governments similarly focused on eliminating deficits by paring spending and reducing debt, and then they started to offer tax relief.

All government spending peaked at 53% of Canadian GDP in 1992 and fell steadily to just under 40% by 2008. (Government spending in the U.S. was 38.8% of GDP that year.) The recession has caused government spending to increase in both countries. But if present trends continue, within two or three years Canada will have a smaller government as a share of its economy than the U.S.

Canadian taxes have also come down at the federal and provincial level. They were reduced with the stated goal of improving incentives for work effort, savings, investment and entrepreneurship.

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Paul Skidmore’s office is shuttered, his job gone, his 18-month job search fruitless and his unemployment benefits exhausted. So at 63, he plans to file this week for Social Security benefits, three years earlier than planned.

“All I want to do is work,” said Skidmore, of Finksburg, Md., who was an insurance claims adjuster for 37 years before his company downsized and closed his office last year. “And nobody will hire me.”

It is one of the most striking fallouts from the bad economy: Social Security is facing a rare shortfall this year as a wave of people like Skidmore opt to collect payments before their full retirement age. Adding to the strain on the trust are reduced tax collections sapped by the country’s historic unemployment ”” still at 9.5 percent.

More people filed for Social Security in 2009 ”” 2.74 million ”” than any year in history

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The leader of the Roman Catholic Church in Scotland has attacked the US over the release of the Lockerbie bomber.

Cardinal Keith O’Brien said the Scottish government was right to free Abdelbaset Ali al-Megrahi last year on compassionate grounds.

US lawmakers want Scots politicians to explain their decision to a committee, but the cardinal said ministers should not go “crawling like lapdogs”.

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